Capital Gains at a Glance
Selling a business at a profit means there is money left over, above the value of business assets. While it is easy to think that capital gains are simply the difference between the value of the business and its final sale price, the IRS does not see it quite so simply. Much of the effects of capital gains tax on sale of a business depend on the type of business entity and ownership of individual assets.
The IRS does not see the business as a whole, but rather as individual capital assets such as equipment, real estate, and inventory. The sale of a business, as far as the IRS is concerned, involves the transfer of individual capital assets. It is possible to realize a capital gain on equipment, for example, while realizing a loss on inventory. As such, selling a business at a profit to the owner does not necessarily equate to selling a business at a profit to the IRS.
The IRS classifies business assets as short term or long term. Short-term assets are held for one year or less. These include finished product inventory, raw materials, and similar assets. Long-term assets are held for more than one year, such as equipment, real estate, or patents. A quick perusal of IRS Schedule D, Capital Gains and Losses provides insight into how the IRS computes gains and losses for the sale of a business using short and long-term asset calculations.
Depending on the nature of the assets involved and the business entity, profits from the sale of a business qualify as either personal income or capital gains. Capital gains tax rates are lower than personal income tax rates. In that regard, owners in the market to sell should want profits to fall in the category of capital gains, rather than personal income. However, each business and individual is different, therefore the effects of capital gains tax on sale of a business varies greatly and warrants consult with a tax professional.